Estate Taxes FAQs
Estate Taxes FAQs
What are estate taxes?
Estate taxes are different from and in addition to probate expenses, which can be avoided with a revocable living trust, and final income taxes, which must be paid on income you receive in the year you die.
Federal estate taxes are expensive (historically, 35%-55%) and they must be paid in cash, usually within nine months after you die. Because few estates have the cash, it has often been necessary to liquidate assets to pay these taxes. But, if you plan ahead, you can reduce and even eliminate estate taxes.
Who has to pay estate taxes?
How is the net value of my estate determined?
How can I eliminate my estate taxes?
- If you are married, use both estate tax exemptions.
- Remove assets from your estate before you die.
- Buy life insurance to replace assets given to charity and/or pay any remaining estate taxes.
- Ensure your assets are distributed according to your will. If you don’t have a valid will, your assets are distributed according to state law.
How to remove assets from your estate?
Appreciating assets are best to give because any future appreciation will also be out of your estate. Gifted assets keep your cost basis (what you paid for them), so recipients may pay capital gains tax when they sell. But the top capital gain gains rate (20%) is still less than the estate tax rate (40%) that would apply if you hold onto the assets until your death.
Some popular strategies are introduced below. Note that these are irrevocable, so you can’t change your mind later.
What are tax-free gifts?
In addition to these annual gifts, you can also make unlimited gifts of tuition or medical expenses so long as the payments are made directly to the institution.
What is a Irrevocable Life Insurance Trust (ILIT)?
Usually the ILIT is also beneficiary of the policy, giving you the option of keeping the proceeds in the trust for years, with periodic distributions to your spouse, children and grandchildren. Proceeds kept in the trust are protected from irresponsible spending, creditors and even spouses.
What is a Qualified Personal Residence Trust (QPRT)?
A QPRT “leverages” your estate tax exemption. Since your children will not receive the house until the trust ends, its value as a gift is reduced. For example, if the current value of your home is $250,000 and you put it in a QPRT for 15 years, its value for tax purposes could be as little as $75,000. That leaves much more of your exemption for other assets.
What are Grantor Retained Annuity Trusts (GRAT) and Grantor Retained Unitrusts (GRUT)?
When the trust ends, the asset will go to the beneficiaries of the trust. Since they will not receive it until then, the value of the gift is reduced. If you die before the trust ends, some or all of the asset may be in your estate.
What are Limited Liability Companies (LLC) and Family Limited Partnerships (FLP)?
Here’s how they work. You and your spouse can set up an LLC or FLP and transfer assets to it. In exchange, you receive ownership interests. Though you have a fiduciary obligation to other owners, you control the LLC (as manager) or FLP (as general partner). You can give ownership interests to your children, which removes value from your taxable estate. These interests cannot be sold or transferred without your approval, and because there is no market for these interests, their value is often discounted. This lets you transfer the underlying assets to your children at a reduced value, without losing control.
What is a Charitable Remainder Trust (CRT)?
With a CRT, you transfer an appreciated asset into an irrevocable trust. In many cases, this has the practical effect of removing the asset from your estate, and if so, no estate taxes will be due on it when you die. You also receive an immediate charitable income tax deduction. The trustee then sells the asset at full market value, paying no capital gains tax, and re-invests the proceeds in income-producing assets. For the rest of your life, the trust pays you an income. When you die, the remaining trust assets go to the charity(ies) you have chosen.
What is a Charitable Lead Trust (CLT)?
Should I buy life insurance?
Can you summarize how to reduce or eliminate Estate Taxes?
- If Married, Use Both Exemptions
- Remove Assets From Estate
- Buy Life Insurance